Earlier in the year I argued that the global economic outlook was clouded by dysfunctional monetary arrangements in Europe, dysfunctional politics in the U.S., opaque politics in China, and a retreat from the open, dynamic international trade and payments system painstakingly constructed over the past 70 years. These four factors remain sources of uncertainty, although Mario Draghi's resolve to preserve the euro zone has provided a respite from the turbulence that threatened to undermine the very foundations of European Monetary Union in the summer and the re-election of a determined, re-invigorated President Obama (and a possibly chastened Republican party) provides some hope that the U.S. fiscal cliff can be averted.
The recent transfer of power in China, meanwhile, highlights the challenges facing the new Chinese leadership. (See the Financial Times discussion withSushil Wadhwani and Gavyn Davies on the challenges here.)That the Communist Party of China derives its legitimacy from delivering sustained growth and rising living standards to the masses has become a truism of geopolitics. Over the past thirty years or so this growth has been achieved by an export-led growth strategy powered by investment in manufacturing goods and enabled by rising debt levels in its key customers. In this respect, the Chinese development strategy is scarcely different from the well-trodden trail blazed by Japan and its other Asian neighbours. It relies on high domestic saving and corresponding high investment rates.
Of course, the Chinese have the benefit of learning from their neighbours' experiences. In this regard, there has been no massive accumulation of external debt denominated in a foreign currency, as was the case in the Asian 'tigers'. But, then again, Japan did not suffer from a mis-matching of debt and an external debt crisis. Japan's problem, rather, was that despite leading the world in consumer electronics, cars and just about everything else, with new sources of low cost production (enter the dragon) the returns on additional investment in manufacturing capacity at home couldn't match the potential returns to be had abroad. Add the pernicious effects of an inflated -- then subsequent burst -- financial bubble that fuelled imprudent investments in real estate and an ageing demographic profile, and you get a decade(s) long stagnation.
It would be wrong to think that China faces a 'tigers' financial crash or a Japan-like period of secular stagnation. Neither of these outcomes is inevitable. But it would be equally misguided to assume that the process of investment driven growth--adding capital to a seemingly limitless supply of capital--can continue indefinitely. Chinese workers are growing impatient with the status quo. Seeing some around them grow wealthy from the process of market-based reforms, they want real wage increases and the consumption that goes with them.The easy part of the development process is over; the next stage will be more challenging.
The most difficult task facing the new leadership, arguably, will be dealing with the challenge of adjustment in export-oriented sectors that have grown up under an infant industry exchange rate regime. That regime provided a degree of certainty to foreign investors that built export capacity. But, with workers wanting higher real incomes, and the prospect of indefinite quantitative easing by advanced economy central banks, that regime is not sustainable over the long term. In this respect, the new leadership faces an enormous political economy challenge of finessing adjustment and balancing the interests of workers, the owners of export-oriented firms (many of whom undoubtedly have close ties to the Communist Party) and the agricultural “masses” in rural China that have not yet been pulled out of poverty.
I have no doubt that the debate over when and how to make the adjustment is already well and truly underway. But, in a society in which fundamental political choices are made in an opaque process, the timing and possible modalities of the regime change are unclear. Of course, given the growing global importance of the Chinese economy, the outcome of the debate and the decisions made regarding these issues can affect investment decisions around the globe.
In this respect, political opacity is one more source of uncertainty in the New Age of Uncertainty.